Custodial Account - newborn/toddler

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sirhc
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11:09p, 12/18/22
AG
I've seen a lot of people recommend a custodial account for your newborn, contribute to it monthly, and help set them up. Invest it in index funds for 18+ years, and then they let it ride until retirement (or they need it) and they should have a nice chunk of change.

My question is - are there any loopholes or ideas to set this up so they avoid a massive tax hit when they decide to use the money?
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techno-ag
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In reply to sirhc • 7:22a, 12/19/22
AG
Why not open a custodial IRA? They can access it for things like tuition and buying a home but otherwise it's subject to typical IRA rules on retirement. Plus it will get an extra 18 years of compounding interest while it's under your control.

https://www.schwab.com/ira/inherited-and-custodial-ira
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permabull
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In reply to techno-ag • 8:17a, 12/19/22
AG
Contributions to an IRA require earned income, so unless they are a model or child actor it's very unlikely you will be able to contribute on their behalf
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mosdefn14
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In reply to sirhc • 8:20a, 12/19/22
AG
sirhc said:
I've seen a lot of people recommend a custodial account for your newborn, contribute to it monthly, and help set them up. Invest it in index funds for 18+ years, and then they let it ride until retirement (or they need it) and they should have a nice chunk of change.

My question is - are there any loopholes or ideas to set this up so they avoid a massive tax hit when they decide to use the money?


You need to consult with an advisor. An account in your name (earmarked) for them is an idea. You maintain control over it, deciding when they're ready for it. It also stays available for you. Depending on the amount it grows to, gift tax (depending on then lifetime exemption rules) could be a concern. Capital gains taxes are another concern, but at the typical 22 year old tax bracket likely not an issue (under current tax laws).

Speaking of custodial accounts, there's a strategy to peel capital gains each year while a minor to stay under their income limits while you claim them. My big concern with custodial accounts (ugma/utma) is they become (by law) the kids at the age of majority. You'd be surprised how many "good kids" turn into animals at 21 or 25, and fresh cash is the absolutely last thing they need.
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techno-ag
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In reply to permabull • 8:28a, 12/19/22
AG
hypeiv said:
Contributions to an IRA require earned income, so unless they are a model or child actor it's very unlikely you will be able to contribute on their behalf
It includes self employment though. So long as a child receives income it's okay. There are countless examples of modeling income from family baby photos, mowing lawns, etc. But you're right, earned income is required.
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sirhc
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In reply to techno-ag • 10:22a, 12/19/22
AG
while my child (2) is cute, not sure I can in good faith claim she is a child model right now. I do agree thats the best route though if you can figure out some type of employment for them
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htxag09
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1:00p, 12/19/22
AG
We just have an account in our name, nicknamed/identified as being for our child.

We have a separate account in his name but it's small and specifically for thinks like money he gets for his birthday, Christmas, etc.

Not telling anyone how to parent or what to do with their money, but millionaire next door opened my eyes to some of the pitfalls of gifting kids money. I always assumed we'd help with the first house, for example. But, more often than not, that hurts them as they feel the need to keep up with the neighbors in a home/neighborhood they can't afford….
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one safe place
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In reply to techno-ag • 1:19p, 12/19/22
techno-ag said:
hypeiv said:
Contributions to an IRA require earned income, so unless they are a model or child actor it's very unlikely you will be able to contribute on their behalf
It includes self employment though. So long as a child receives income it's okay. There are countless examples of modeling income from family baby photos, mowing lawns, etc. But you're right, earned income is required.
And don't forget, the child will have to file a tax return to pay the self-employment tax if the self-employment net earnings is $400 or more. If you stay below the filing threshold, the IRA contribution will be very small.
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Showertime at the Bidens
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10:11p, 12/19/22
I split the kids college fund between 529s and custodial accounts. Partly because who knows what education is going to look like in the next decade. If kids decide they want to go some alternative certification route that's not covered by 529 they'll have access to the custodial account.
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K_P
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7:14a, 12/20/22
AG
I have a UTMA accounts that are small $$, less than $2k in each at this point. It's more about teaching them investing: "I bought this CSX stock when you were 2 because you loved trains and they were innovative in how trains are scheduled, I bought this VOO when you were born because index investing is good, etc."

Their real "inheritance" is held in my name and will be until estate tax is clearly a concern.
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ag0207
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8:48a, 12/20/22
AG
We have custodial accounts and 529's for both kids. I know that they will eventually take ownership of the accounts but I will probably keep the details of it very vague until they become responsible adults.
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MyNameIsJeff
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In reply to ag0207 • 10:41a, 12/21/22
AG
ag0207 said:
We have custodial accounts and 529's for both kids. I know that they will eventually take ownership of the accounts but I will probably keep the details of it very vague until they become responsible adults.
This is what we've done, too. Opened them through Fidelity right after the birth of our first son with automatic monthly contributions. My plan is to adjust the contribution to the 529 annually to fully fund 4 years at the current cost of attendance at A&M. It is currently showing a surplus, but I only expect costs to increase.

As far as my kids having access to a large sum of money early on, I can only hope the 18 years we have to teach them about finances allows them to make sound decisions.
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txaggie_08
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In reply to Showertime at the Bidens • 4:17p, 2/19/23
AG
Zarathustra said:
I split the kids college fund between 529s and custodial accounts. Partly because who knows what education is going to look like in the next decade. If kids decide they want to go some alternative certification route that's not covered by 529 they'll have access to the custodial account.

I have done the same, although majority of funding, 80%, is going to the 529.
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Kenneth_2003
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9:16p, 2/19/23
AG
I think that whatever you do, you are setting your child(ren) on a path for potential financial security well above that of their peers. The tax implications one could debate now and tomorrow with hindsight, but the result will be the same. Your child(ren) will be well positioned for success.

Disclosure... I wen to school on a UTMA account comprised of stock in the company my father worked for. My fathers cost basis (transferred to me via the account structure) kicked my rear during college, but it paid for college. 2008 destroyed that companies value and years later I walked away from those assets for pennies on the previous dollars. But I graduated from TAMU debt free, that was worth plenty.
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one safe place
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In reply to Kenneth_2003 • 10:41p, 2/19/23
Kenneth_2003 said:
I think that whatever you do, you are setting your child(ren) on a path for potential financial security well above that of their peers. The tax implications one could debate now and tomorrow with hindsight, but the result will be the same. Your child(ren) will be well positioned for success.

Disclosure... I wen to school on a UTMA account comprised of stock in the company my father worked for. My fathers cost basis (transferred to me via the account structure) kicked my rear during college, but it paid for college. 2008 destroyed that companies value and years later I walked away from those assets for pennies on the previous dollars. But I graduated from TAMU debt free, that was worth plenty.
I agree wholeheartedly with your post and have thought the same thing many times when this topic comes up. The main thing is that you start setting money aside, as in every single month. Automatic draft is the way to go. Custodial account, 529 plan, bury it in Mason jars in the back yard, but start and don't stop. When it comes time to write those $15,000 checks each semester you will pat yourself on the back and think what a genius you were.

We started doing that for each of our three soon after they were born. The first one decided to run off right after high school with a guy in the Marines, that marriage lasted about 10 months and she came back home, pregnant. But she started college, got out in four years. By the time all this went down, my income had gone up enough that we funded her education mostly out of cash flow. She had enough left over to put like 40% down on a house right after she graduated and the notes were low enough for a single mom to deal with. Nice home, nice neighborhood. Because she was a single mom, I did the same thing for her baby, my granddaughter. She is now in her second semester at A&M and plenty of money set aside for all that.

I admire all of you who are making the effort to set aside funds. Lord knows the costs will continue upward and getting started early is the way to go. Good luck!
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Buzzy
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In reply to mosdefn14 • 9:24p, 2/20/23

One of the only pieces of investing advice I've heard Dave Ramsey give that was solid was a recommendation on a Roth IRA for this purpose. He pointed out the pitfalls of custodial accounts that you did, i.e. what if your kid was screwing up when they reach the age of majority and a big influx of cash is the worst thing for them? He recommended a Roth IRA you contribute to for 18 years, and then if you want to use it to pay for college, pull the contributions, now the growth. There is no tax consequences in this scenario and you retain control over the money because the IRA is in your name.
Wild West Pimp Style
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2wealfth Man
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In reply to Buzzy • 1:38p, 2/21/23
AG
Buzzy said:

One of the only pieces of investing advice I've heard Dave Ramsey give that was solid was a recommendation on a Roth IRA for this purpose. He pointed out the pitfalls of custodial accounts that you did, i.e. what if your kid was screwing up when they reach the age of majority and a big influx of cash is the worst thing for them? He recommended a Roth IRA you contribute to for 18 years, and then if you want to use it to pay for college, pull the contributions, now the growth. There is no tax consequences in this scenario and you retain control over the money because the IRA is in your name.
just make sure you don't run afoul of the MAGI limits for being able to contribute to a Roth
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